Hockey is right; and the growth in house prices is falling

The RBA rear view mirror analysis of house prices is very confusing. Earlier in the year when it could have gotten away with an interest rate hike to cool housing (among other things), it mentioned house price growth without a hint of concern. This was when house prices were running rampant.

Now, six months later, when there are clear signs of a moderation or cooling in house prices, the Minutes of the September RBA Board meeting noted "housing prices had been rising at a rapid pace" and that "Members further observed that additional speculative demand could amplify the property price cycle".

The odd thing with the RBA about-face is that house prices are now the weakest they've been in several years.

According to the RPData house price series, in the four and half months since the end of April, house prices have risen by just 1.6 per cent, which is an average monthly pace of 0.35 per cent or an annual rate at a very comfortable 4.25 per cent.

To be sure, with interest rates still very low and the supply and demand imbalance at least a little bit skewed towards a small housing shortage, house prices are likely to be supported. That assumes, of course, that the recent increase in the unemployment rate is not sustained, nor is damaging to the credit quality of mortgage holders. These are big assumptions at the moment when overlayed with a worrisome fall in real wages.

The RBA is slow to recognise the turning point in house prices. While some jawboning of house prices is no bad thing, they are afterall still high, the RBA risks holding monetary policy too tight because of this misreading of the housing market.

Treasurer Joe Hockey was spot on today with his comments at the Bloomberg Summit in Sydney. Mr Hockey said, "Australia fundamentally doesn't produce enough houses to meet demand, it is just an infinite mantra for international commentators, for analysts based overseas to say 'well, you know, there's a bit of a housing bubble emerging in Australia'. That is rather a lazy analysis, because fundamentally we don't have enough supply to meet demand. That doesn't suggest there's a bubble; there might be a price increase of some substance, but you'd expect the market to react and produce some more housing."

And with building approvals running near record levels, the supply side is responding. Mr Hockey gets it, it seems.

Mr Hockey and his team would be wise to raise this at his next meeting with RBA Governor Stevens. Let's hope the RBA does not make a policy mistake of holding monetary policy inappropriately tight as it fights last year's battle. It doesn't need to tighten policy given the house price boom is slowing, it is just that not many people including those at the RBA are aware of it.

Word has it that the framing of the budget, due to be handed down by Treasurer Josh Frydenberg the day after April fools day (and around 6 weeks before the election), is more problematic than usual.

Problematic because there is some mixed news on the economy that will threaten the current forecast of a return to budget surplus in 2019-20.

Housing has gone into near free-fall, both in terms of prices and new dwelling approvals. This is bad news for GDP growth. The unexpected severity of the housing slump is the key point that will see Treasury revise its forecasts for GDP growth, inflation and wages lower when the budget is handed down.

It will be impossible for Treasury to ignore the recent run of hard data, including the weakness in consumer spending and a generally downbeat tone in the recent economic news when it sets the economic parameters that will underpin its estimates of tax revenue and government spending and therefore whether the budget is in surplus or deficit.

The prospect that interest rates will be lowered within the next few months is already starting to impact on the economy.

Here’s how.

Around the middle of 2018, financial markets were expecting the RBA to hike official interest rates to 1.75 or 2 per cent over the course of the next 18 months or so. If proof was needed that investors and economists can get it wrong, markets are now pricing in official interest rates to be cut towards 1 per cent over the next 18 months.

The about face has been driven by a raft of disappointing news on the economy, most notably the fall in house prices, the free-fall in new dwelling building approvals and a slump in retail spending growth.

Business confidence has also taken a hit and job advertisements have been falling for eight straight months. Ongoing low inflation and increasing signs of a slowdown in the global economy have simply added to the case for this dramatic change in market pricing.